W1 Flashcards
Macroeconomics
the study of structure and performance of national economies and government policies that affect economic performance.
Two main sources of Economic growth
Population growth; and
Increases in average labor productivity (output produced per employed worker
Business cycles, upward and downward trend
Business cycle: Short-run contractions and expansions in economic activity.
Downward phase is called a recession/upward phase is called a boom.
Unemployment
the number of people who are available for work and actively seeking work but cannot find jobs. Recessions cause unemployment rate to rise
Inflation rate
the percentage increase in the level of prices.
Deflation
when prices of most goods and services decline.
Hyperinflation
an extremely high rate of inflation.
Open economy
has extensive trading and financial relationships with other national economies.
Closed economy
an economy that does not interact economically with the rest of the world.
Trade surplus and deficit
Trade surplus: exports exceed imports.
Trade deficit: imports exceed exports.
Fiscal policy
government spending and taxation
Monetary policy
growth of money supply; IR-targeting
Macro forecasting
Relatively few economists make forecasts.
Forecasting is very difficult.
Macro analysis
Private and public sector economistsโanalyse current conditions.
Public sector employs many macroeconomic analysts who provide policy advice.
Macro research goal
to make general statements about how the economy works.
Theoretical and empirical research necessary for forecasting and economic analysis (2)
Economic theory: a set of ideas about the economy, organized in a logical framework.
Economic model: a simplified description of some aspect of the economy.
Usefulness of (2)
Depends on
- reasonableness of assumptions
- possibility of being applied to real problems
- empirically testable implications
- theoretical results consistent with real-world data.
5 Steps for Developing and Testing an Economic Theory
Step 1: State the research question.
Step 2: Make provisional assumptions.
Step 3: Work out the implications of the theory.
Step 4: Conduct an empirical analysis to compare the implications of the theory with the data.
Step 5: Evaluate the results of your comparisons.
2 Disagreements
Classicals vs. Keynesians.
classical approach (invisible hand, wages + prices, result)
- The โinvisible handโ: the idea that if there are free markets and individuals conduct their economic affairs in their own best interests, the overall economy will work well.
- Wages and prices adjust rapidly to get to equilibrium.
Changes in wages and prices are signals that coordinate peopleโs actions. - Result: Government should have only a limited role in the economy.
The Keynesian approach
Keynes: Persistent unemployment occurs because wages and prices adjust slowly, so markets remain out of equilibrium for long periods.
Therefore, Government should intervene to restore full employment.
The evolution of the classicalโKeynesian debate
- Keynesians dominated from WWII to 1970.
- Stagflation led to a classical comeback in the 1970s.
- Last 30 years: excellent research with both approaches.
unified approach to macroeconomics using a single model: 3 markets, LR, SR
Three markets: goods, assets, labor.
Long run: wages and prices are perfectly flexible.
Short run: Classical caseโflexible wages and prices; Keynesian caseโwages and prices are slow to adjust.
The National income accounts
accounting framework used to measure economic activity.
Three alternative approaches
Product approach: the amount of output produced.
Income approach: the incomes generated by production.
Expenditure approach: the amount of spending by purchasers
Expenditure approach (what is GDP)
โtotal spending on final goods and services produced within a nation during a specified period of timeโ
income-expenditure identity
๐=๐ฎ๐ซ๐ท=๐ช+๐ฐ+๐ฎ+๐ต๐ฟ
Consumption
- Spending by domestic households on final G+S (including those produced abroad).
3 categories of C
- Consumer durables (e.g., cars, TVs, furniture, major appliances).
- Nondurable goods (e.g., food, clothing, fuel).
- Services (e.g., education, health care, financial services, transportation).
Investment (I)
Spending for new capital goods (fixed investment) plus inventory investment.
3 major components (i)
- Business (or non-residential) fixed investment: spending by businesses on structures, equipment, and intellectual property products (i.e., software, research and development etc.).
- Residential fixed investment: spending on the construction of houses and apartment buildings.
- Inventory investment: increases in firmsโ inventory holdings.
Government purchases of G+S (G) AND examples of capital goods spending
Spending by the government on G+S.
- capital goods add to the nationโs capital stock (e.g., highways, airports, bridges, and water and sewer systems).
Excluded GS (4)
- social Security payments
- welfare
- unemployment benefits.
- Interest payments on government debt.
Net exports (NX)
Exports: goods produced in the country that are purchased by foreigners.
Imports: goods produced abroad that are purchased by residents in the country.
Imports are subtracted from GDP, as they represent goods produced abroad, and were included in consumption, investment, and government purchases.
Real GDP
an estimate of the value of an economyโs final output, adjusting for changes in the overall price level.
Real GDP growth EQ (s19)
[quarterly annualized GDP growth rates]
โ๐/๐=(๐(๐ก)/๐(๐กโ1) )^4โ1
price index
measures the average level of prices for some specified set of G+S, relative to the prices in a specified base year.
GDP deflator
is a price index that measures the overall level of prices of G+S included in GDP
GDP deflator EQ (S23)
Real GDP=(Nominal GDP)/(((GDP deflator)/100) )
THEREFORE,
GDP deflator=(Nominal GDP)/(Real GDP)ร100
consumer price index (CPI)
measures the prices of consumer goods (available at monthly frequency).
Difference between GDP deflator and CPI measures
GDP deflator - measures the average level of prices of goods and services included in GDP.
CPI- measures the prices of consumer goods (available at monthly frequency).
Changes in the CPI leads to an important macro variable _______
Inflation rate.
inflation rate (S24)
๐_๐ก=((๐_๐กโ๐_(๐กโ1) ))/๐_๐ก =(โ๐_๐ก)/๐_๐ก
Why economists care about Inflation (3 points)
- Inflation affects income distribution when not all prices and wages rise proportionally.
- Inflation leads to distortions due to uncertainty, some prices that are fixed by law or by regulation, and its interaction with taxation.
- Most economists believe the โbestโ rate of inflation to be a low and stable rate of inflation between 1 and 4%.
real interest rate (or real rate of return) on an asset
the rate at which the real value or purchasing power of the asset increases over time.
The nominal interest rate (or nominal rate of return)
the rate at which the nominal value of an asset increases over time.
RII Equation
real interest rate=๐ โ ๐
nominal - infl r
expected real interest rate
expected real interest rate is the rate at which the real value of an asset is expected to increase over time.
nominal interest rate minus the expected rate of inflation:
๐=๐โ๐^๐
How do borrowers, lenders and depositors make financial decisions
how much to borrow, lend, or deposit is dependant on the basis of the real interest rate they EXPECT to prevail.
if expectations are correct i.e expected and actual inflation is correct then ____________
the expected real interest rate and the real interest rate actually received will be the same. i.e., โ ๐=๐^๐
Difference between GDP and GNP
GNP is the market value of final goods and services newly produced by domestic factors of production during the current period, whereas GDP is production taking place within a country.
Thus, GNP differs from GDP when foreign factors are used to produce output in a country, or when domestic factors are used to produce output in another country.
NFP definition
NFP = net factor payments from abroad, which equals income paid to domestic factors of production by the rest of the world minus income paid to foreign factors of production by the domestic economy.
A country that employs many foreign workers will likely have _____ NFP, so GDP will be _____ than GNP.
negative ; higher
How are net exports, net factor payments from abroad, and the current account balance related?
The sum of net exports (NX) and net factor payments from abroad (NFP) equals the current account balance (CA). This relationship is given as NX + NFP = CA.
If A lends to B, and expected inflation rate is
(i) HIGHER than expected
(ii) LOWER than expected
who benefits in the above circumstances?
(i) B gains from unexpectedly high inflation, because B repays the loan with dollars that arenโt worth as much as was expected.
(ii) A gains from unexpectedly low inflation, because A gets repaid with dollars that are worth more than was expected.
